Security Deposit: Definition, Primary Purpose, and Example

What Is a Security Deposit?

A security deposit is money that is given to a landlord, lender, or seller of a home or apartment as proof of intent to move in and care for the domicile. Security deposits can either be refundable or nonrefundable, depending on the terms of the transaction. A security deposit is intended as a measure of security for the recipient, and can also be used to pay for damages or lost property.

Security deposits serve as an intangible measure of security, or as a means of tangible security in the event of damages or lost property.

How a Security Deposit Works 

Security deposits are paid before moving in or taking possession of the property and these deposits are typically the same amount as the monthly rent. A security deposit might be used toward any repairs or replacement of appliances in a rental unit if the damages resulted from the actions of the renter.

For example, if a renter breaks a window or causes permanent damage to the floors, walls or infrastructure of the property, then the landlord can use the security deposit toward repairs. Typically, if the property is in good condition and without the need for repair when the renter moves out, the security deposit may be refunded to them.

Requirements for a Security Deposit 

The amount of a security deposit is typically one month’s rent but can be higher. If the rental rate on a property increases, the security deposit that is held in escrow might not be sufficient.

Security deposits can accrue interest while they are held but the rate of rent increases might exceed that interest. The renter would then need to add more money to the security deposit that is being held.

Security deposits are not considered taxable income, and local laws often treat security deposits as trust funds. Security deposits that are used as final rent payments must be claimed as advance rent and are taxable when paid.

Special Considerations 

In some states, landlords might apply security deposits as rent from tenants who cannot otherwise pay or use the deposits to repair damage caused by tenants. Each state may stipulate whether or not a security deposit can be used to pay the final month’s rent when occupancy of a property comes to an end. Depending on local legislation, the final month’s rent and a security deposit might not be the same and must be accounted for separately. The landlord could even need written approval from the renter to use a security deposit as final rent.

There may be challenges to the amount required for security deposits in particular cities or neighborhoods. Some districts could have landlords who charge higher security deposit rates compared with surrounding areas. This can have the effect of forcing lower-income individuals and families from finding places to live in those areas. Local legislation might be enacted that sets limits on how large a security deposit may be in relation to the rent charged for a property.